The Fuse

Banks React to OPEC Meeting, See Prices Lower for Longer

by Matt Piotrowski | December 07, 2015

Global oil prices fell in response to last week’s OPEC meeting that apparently ended in acrimony as members did not agree on an output cut and failed to set a new production target. Nymex West Texas Intermediate (WTI) dropped below $40 per barrel and ICE Brent dropped to $42.68. Some analysts see a possibility the market could fall further, with non-OPEC supply and emerging market demand growth just as critical as OPEC output in shaping fundamental balances in the months to come.

The group scrapped its previous output ceiling of 30 million barrels per day without coming up with a new target.

The group scrapped its previous output ceiling of 30 million barrels per day without coming up with a new target. But the main news out of Vienna was that the status quo will remain: The Saudi-led “free market” strategy continues, meaning prices are poised to remain lower for longer. OPEC is currently producing around 31.5 to 32 mbd. In November 2014, the group, led by the Kingdom, opted to fight for market share instead of cutting back output to lift prices. Saudi Arabia did not want to lose market share and in turn subsidize high-cost non-OPEC production, such as U.S. shale.

While the group is already pumping at high levels, there will be more oil next year, with Iran set to increase its export volumes once sanctions are lifted. Iranian Oil Minister Bijan Zanganeh was quoted on his arrival to Vienna as promising a 500k barrel per day increase in Iran’s exports in early 2016, rising to 1 mbd by end of year. This return is one of the main reasons for uncertainty in 2016, with OPEC Secretary-General Abdallah Salem El Badri saying that the group will have a clearer picture on what the output ceiling should be at the next meeting in June.

Dysfunction in the cartel

But it’s not only the current strategy that portends low oil prices for the foreseeable future. The group’s apparent dysfunction, along with Iran’s return to the market in 2016, is another ominous sign. The fact that the group could not agree on a revised production target reflects that the cartel’s members are at odds and are unlikely to come to a consensus anytime soon to successfully manage the market.

“In our view, the lack of guidance on a production quota underlines the discord among members. Past communiques have at least included statements to adhere, strictly adhere, or maintain output in line with the production target,” said Barclays analysts in a note on Friday. “For OPEC, managing the impossible trinity of achieving higher market share, higher prices and higher demand through a nominal target which members continue to breach continues to be difficult.”

They added: “OPEC matters when other supply is inelastic, but shale can be and already is reactive to prices, making the cartel less relevant as a balancing mechanism for prices.”

“For OPEC, managing the impossible trinity of achieving higher market share, higher prices and higher demand through a nominal target which members continue to breach continues to be difficult.”

This morning, Citi Futures expressed similar sentiments, saying, “The oil market is rendering a clear bearish verdict on the outcome of Friday’s OPEC meeting with a drop of more than 4.0 percent that has already taken the Brent market to a fresh six-year low. There are those still inclined to spin OPEC’s lack of discipline as an intentional plan designed to capture market share and lead to a stronger market over the intermediate to longer term, but it may be the Iranian oil minister’s summation of the policy as “everyone does whatever they want” that is resonating with traders. The ripple effects are including a weaker Russian ruble, a weaker Canadian dollar, and a stronger US dollar that feeds back as another reason to sell crude oil.”

While the view that OPEC is facing strong signs of internal stress is widely shared, as Saudi Arabia’s Oil Minister Ali al-Naimi emphasized many times during the meeting, “We have said on more than one occasion we are willing to cooperate with anyone who genuinely wants to balance the market,” including non-OPEC members such as Russia, leaving the door open for future collusion.

Market to balance in 2H 2016?

Most analysts expect the global oil market to start balancing during the second half of next year, as non-OPEC supply falls and demand growth is stimulated from low prices. But until then, there will be continued pain among producers inside and outside the group.

“There was no decision on a new target ceiling, with the decision on how to accommodate higher Iranian production left to the next meeting in June,” said Goldman Sachs analysts in a report. “Comments further stressed the need for the oil market to rebalance on its own (‘wait and watch’) and the organization made no comment on adhering to country level quotas.”

Both Barclays and Goldman forecast the global oil market to rebalance in the fourth quarter of next year, which would be about two years after OPEC’s historic decision. The extended period of low prices has hurt all producers, with Venezuela getting hit the hardest.

Despite seeing the market rebalance late next year, Goldman notes that prices could retreat to the $20 area. “There are high risks that this may prove too slow an adjustment as inventories continue to accumulate and storage utilization nears high levels in the face of a mild winter, slowing emerging market growth and a potential lift of international Iranian sanctions,” the analysts write. “The rising probability that markets may need to adjust through ‘operational stress,’ when surpluses breach capacity, leaves risks to our forecast as skewed to the downside in coming months, with cash costs near $20/bbl.”

OPEC is banking on non-OPEC supply contracting next year and global demand rising by a robust 1.3 mbd. But if the situations on the supply and demand side do not play out accordingly, the meeting in June will be even more contentious.